Two of Oregon’s largest private sector firms have been in the news in recent weeks and months with either actual expansions or announcements of expansion plans. These large investments, both in physical property and increased employment, are welcomed news for the state’s economy. However these announcements, along with new reports and legislation, got me thinking about economic growth in a broader sense. This will be a two post series of musings. This first post takes a look at what Oregon’s tax code offers to businesses and how competitive the state is relative to neighboring states. The second post will examine some of the location decisions by firms, what the economic impact may be and also, more broadly, firm size and job creation.
What follows is a discussion surrounding so-called C corporations and how Oregon’s tax code treats these businesses. Pass through entities, such as S corporations, and some LLCs are treated differently and generally pay taxes under the personal income tax code and are not discussed below. The following is effectively a summary of or at least highly leveraged from the recent research report issued by the Legislative Revenue Office.
A new research report by the Legislative Revenue Office examines two recent studies on state tax competitiveness, one by Ernst & Young for the Council on State Taxation and one by KPMG for the Tax Foundation, and also furthers the analysis with 2 primary case studies comparing across western states. The Oregonian’s Christian Gaston wrote a nice summary article of the findings based on the LRO report and on a presentation Paul Warner gave to the legislature.
First, Oregon levies a corporate income or corporate excise tax on entities doing business in the state or have income sourced from Oregon. C corporations pay the larger amount of either the minimum tax (based on the level of annual sales and established under Measure 67) or 6.6% of taxable income up to $10 million or 7.6% of taxable income over this amount. Where taxes can get more complicated (as they always can) is for businesses with multistate presences (operations, employees, sales, etc) and how to divide their assets and sales among locations for tax purposes. From a separate LRO document explaining single sales factor apportionment:
Corporations that conduct business in multiple states are affected by how each state taxes corporate income… In 1965 Oregon adopted in statute certain provisions… [that] provides a method for dividing corporate taxable income among states according to each state’s share of a corporation’s property, payroll and sales.
Through 1990 each of these factors was given equal weight (33%) however beginning in 1991 the state moved to 50% weighted sales and 25% for payroll and property. In 2003 the sales factor increased to 80% and in 2005 the state moved wholly to single sales factor meaning 100% for sales and 0% for payroll or property.
As stated in the document: “because a heavily-weighted sales factor formula focuses more on taxing consumption, it tends to benefit in-state companies that have large investments in property and payroll.” The Institute on Taxation and Economic Policy states that while single sales may make a state a more attractive place to expand or locate for firms with a large plant/facility or large number of employees, it also makes it relatively more expensive for firms selling in that state that do not have either a large facility or large number of employees. In other words, the single sales factor benefits companies with a large in-state presence, particularly those who sell most of their products out of state. On the flip side, the companies who are the least advantaged by this structure are those out-of-state companies with little physical presence in the state however sell a lot of goods or services in the state. It is not necessarily that these firms or industries do not employ thousands of workers, as they do, but relative to their volume of sales their physical presence is not proportionately large.
It is precisely this tax structure that Nike wants to cement as it is more advantageous for their headquarters and Oregon operations than the three factor formula would be. While there appears to be no known movement on changing the apportionment formula, future legislatures or citizen initiatives may prove otherwise and reaching a long term agreement would lock in the current tax structure. This, in a nutshell, is why Governor Kitzhaber called the legislature into special session last week and why the legislature ultimately passed HB 4200.
Now, back to the competitiveness of Oregon’s tax structure.
Both the Council on State Taxation and the Tax Foundation studies calculate effective tax rates for prototype corporations making location or expansion decisions. Oregon generally ranks middle of the pack to top of the pack in business cost studies, depending upon the exact focus and variables used and these two prove no exception. Oregon ranks 2nd best in the Council of State Taxation study but 30th best in the Tax Foundation study. The difference here is due to some important methodological differences that the Legislative Revenue Office research report highlights.
In particular the treatment by each study on apportioning “nowhere income” or if a state had adopted a “throwback rule.” As LRO writes:
This occurs when a corporation has sales to a state where it does not have nexus and therefore cannot be taxed. States have the choice of ignoring this income for their own tax purposes or adopting a “throwback rule” in which sales from the state where there is no nexus are included in the sales of the originating state.
Oregon does have a throwback rule and the two national studies apply different throwback rates and assumptions to this “nowhere income,” thus swaying the ranking to some degree. The Council on State Taxation assumes a 0% throwback while the Tax Foundation assumes a 100% throwback. The truth is somewhere in between and varies from corporation to corporation, however LRO examined manufacturing corporate tax returns in Oregon and found that it averages 10%. That is, about 10% of a company’s sales outside Oregon are sourced back to the Oregon tax return, on which the corporation must pay taxes, due to the throwback rule.
The LRO report has a more thorough discussion surrounding the two studies’ assumptions including, inclusion of the unemployment insurance tax, tax incentives, treatment of local taxes and different investment types, which do impact the overall effective tax rate and rankings.
The other important component of the research report are the two main case studies in which LRO compares business costs across western states (Oregon, Washington, Idaho, California, Colorado, Utah and Nevada.) The first case study is a Capital Intensive Manufacturing Facility with $200 million in revenue, 100% located in the state and sell 75% of its products outside Oregon. From the report’s conclusion, examining the results of this case study:
The state’s sales based apportionment formula for tangible goods (along with a realistic estimate of throwback sales) and the lack of a sales tax on business purchases act to reduce the corporate tax burden on most manufacturers locating in the state. These two factors give Oregon a regional competitive advantage for manufacturing investment… From a purely tax perspective, the state appears to be well positioned to attract these types of investments.
The second case study is a Service Based Facility with $75 million in revenue and 50% of sales made in Oregon. Also from the conclusion:
For export oriented service companies, Oregon’s apportionment formula is not an advantage in attracting new investment… This approach leads to higher corporate income taxes in Oregon relative to states with a market based approach to apportioning income from services. As a result, Oregon ranks below two comparative states [Nevada, Utah] in terms of the effective tax rate on a hypothetical service company investment. If Oregon were to shift to a market based approach, the state’s effective tax rate would drop to the lowest in the region.
Finally, while the LRO report examines C corporations, the impact of personal income taxes not only affects S corps, some LLCs and the like, it may play into the ultimate decision of firm location as executives may take into account this tax rate.
Building personal income tax rates into the analysis reduces Oregon’s regional tax competitiveness. A hypothetical case designed to represent an investment in a headquarters operation with a group of high income executives, shows that Oregon’s effective tax rate would rise relative to other states in the region. While this is a specialized case, high personal income taxes are likely to be a factor in many other cases as well, especially those involving pass-through business entities that pay income taxes through the personal income tax rather than the corporate income tax.
Overall, Oregon ranks competitively from a business tax perspective at both the national and regional level. Business taxation is not the sole determinant of business location as myriad other factors are taken into account, including the cost and skill of the labor force, geographic location, physical infrastructure to name just three. Taxes are not generally the be all and end all but they do certainly play an important role. Please do read the LRO research report as it is full very valuable information concerning the nuances and details of corporate taxes in both Oregon and across states.